Cosigning a Student Loan: Pros & Cons

Student Loan Cosigner

Cosigning a Student Loan: Pros & Cons

The process of taking SAT/ACT exams, sending out handfuls of college applications, and eventually deciding on your school of choice is an emotional rollercoaster ride for even the most prepared and least anxious of students. At the very end of this arduous process, students (and parents!) find themselves at the very beginning of the next undertaking: financing a college education.

For lucky students, their parents or extended relatives are there to help. For many others, student loans are oftentimes the only viable option. As an immediate family member, extended relative, or family friend of someone pursuing a university-level education, you may be approached to cosign a student loan.

Much attention is given to student loans, however little attention is given to the impact of cosigning a student loan. For anyone that is considering a role as a cosigner, besides acknowledging the obvious benefit to the student borrower (i.e. they’ll be able to qualify for the loan!), it’s also necessary to know what’s at stake for you.

Who can cosign a student loan:
More often than not, a cosigner can be anyone with a strong credit history who has a willingness to help the student in question.

All lenders have their own cosigner requirements, however many institutions require cosigners to have a credit score of 670 or better and sufficient income to pay back the loan in the event the primary borrower defaults and is unable to repay. There are cases when lenders will go a step further to get a better sense of the cosigner’s overall stability – this can include reviewing the cosigner’s job history, how long they’ve lived in their home, and whether they’ve been in their job for at least a year.

Additionally, one of the least discussed (yet most important!) topics for deciding who should cosign a loan is the cosigner’s health. Many private lenders include language in the lending agreements that allow them to demand that the loan be paid in full upon the death of the cosigner. This is a point that deserves more attention considering that it’s not uncommon for grandparents (many who are older and may not be in their best health) to serve as cosigners.

What does it mean to cosign a student loan:
Personally, I’ve never encountered a student fresh out of high school who met the requirements to take out a student loan without a cosigner. This is likely due to their limited income and minimal (often non-existent) credit history. As the cosigner of a student loan, you are guaranteeing repayment of the debt. As cosigner, you hold a legal obligation to take over debt repayment in the event the borrower cannot keep up.

When banks lend money to borrowers for real estate in the form of a mortgage, the property itself serves as collateral. If the borrower is unable to keep up with their payments, the lender has peace of mind knowing it can cut its losses by seizing the property and selling it to a new buyer.

Considering that student loans are not backed by any physical collateral that can be seized and resold, a cosigner is a bank’s best option to recover an owed student debt.

Naturally, many students look towards their financially-stable family members to cosign student loans.

When parents or family friends of the borrower ask me for my thoughts on cosigning a student’s debt, I ask two questions:

  • Are you prepared for the responsibility to pay off this debt if the borrower cannot keep up with payments?
    • If no, DON’T cosign!
    • If yes, next question…
  • Do you, personally, have any large upcoming purchases/investments that will require borrowing a large sum of money (such as a new home purchase/mortgage or business loan)?
    • If yes, maybe don’t cosign. REASON: The cosigned loans will show up on your credit report and may complicate/restrict your ability to borrow.
    • If no, consider the borrower, your relationship with that person, and your confidence that they will be responsible in repaying the debt. If you accept the risks of being a cosigner and trust the borrower’s explicit commitment to repay the debt – go for it.

Benefits of cosigning a student loan:
For starters, the student borrowers are the primary beneficiaries of a cosigned loan. Cosigners allow students who would otherwise not qualify for a student loan to qualify and secure the funding needed to pursue their education. Additionally, if the cosigner is someone with stellar credit and strong income, the lender may take these facts into account and offer loans with lower, more competitive interest rates.

Many borrowers need cosigners for student loans due to not having much (if any) credit history. By having a student loan in their name and staying consistent on their monthly repayment, student borrowers are making significant (albeit unintentional) strides in establishing a personal credit history.

For cosigners, there’s little personal benefit to cosigning a loan (besides seeing a potential loved one pursue their dreams).

Drawbacks of cosigning a student loan:
A cosigner’s credit score will be impacted if the primary borrower misses a payment. Despite effectively serving as co-borrowers, cosigners rarely ever receive any formal notice that the primary borrower (i.e. the student) has missed payments. Unfortunately, missed payments are a common occurrence that frequently occur when borrowers are not setup for autopay or when a new loan servicer assumes the loan.

Another drawback to cosigning a loan is its impact on the cosigner’s debt-to-income ratio. As discussed before, the cosigned loan will show up on a cosigner’s credit report and may therefore reduce the cosigner’s ability to qualify for a personal loan or mortgage. Even if able to qualify for the loan, the increased debt-to-income ratio may result in the cosigner ending up with a less competitive interest rate.

In the event that the borrower is unable to repay the loan, collection agencies will look to the cosigner for payment. For most cosigners, this is the most significant drawback to cosigning a student loan and the one that must be most seriously considered when deciding to serve as a cosigner.

Even in the best of circumstances, a borrower and cosigner’s financial entanglement leaves the door wide open for relational stress.

How to decide whether to cosign a loan:
Making the final decision whether or not to cosign is personal. At a minimum, cosigners should have a sincere conversation with the prospective borrower to ensure the borrower understands the implications, and risk, to a) themselves and b) the cosigner.

It’s recommended that prospective cosigners also take an inventory of their own finances during this process. Be sure to consider your credit and to factor in whether or not any upcoming expenses will require a loan.

How to get a cosigner release:
Unfortunately, loan servicing companies never voluntarily let borrowers or cosigners know when they qualify for a cosigner release. Getting a cosigner release for a student loan typically requires that the borrower has graduated from school, has made at least 12 on-time payments, and has a sufficient credit score (credit score > 600) and income to repay the debt on their own. Additionally, it’s also typical that loan servicers will request the borrower (not the cosigner) to initiate the release process.

As a financial planning firm, we have clients who are the borrowers and others who are the cosigners. Regardless of borrower/cosigner status, we always work to have cosigners released as soon as possible.

  • Benefit of cosigner release to borrowers: Many private student loan promissory notes have provisions that allow the servicer to place the borrower in default (even if payments have been made on time) if the cosigner dies or files for bankruptcy. Releasing the cosigner as early as possible can prevent borrowers from experiencing surprise defaults and student loan balances automatically being due in full that are no fault of their own.
  • Benefit of cosigner release to cosigners: A parent or family member opts to cosign a student loan so that the borrower can pursue an advanced education. From the very beginning, it should be understood that releasing the cosigner should be a priority following the borrower’s graduation. Getting released as a cosigner means the former cosigner’s credit will no longer be impacted by missed payments and that the original borrower will be fully accountable for the debt.

The Consumer Federal Protection Bureau (CFPB) offers sample letter templates that borrowers/cosigners can send to servicers to request a consigner release.

For additional reading, our co-founder, Dennis McNamara, was featured in Forbes on this topic: https://www.forbes.com/advisor/student-loans/pros-and-cons-of-co-signing-a-student-loan/

Webinar: Financial Crash Course For DOCTORS

FINANCIAL CRASH COURSE FOR DOCTORS

wHealth Advisors is excited to announce a free webinar to help doctors (and those in training) get on a path towards financial independence.

Financial independence? Say what?

In a nutshell, financial independence means being financially secure enough that you continue working because you want to, not because you need to. Everyone’s situation is unique. Just as a good salary does not guarantee financial independence, mountains of student debt does not disqualify you.

For some, financial independence will mean making sacrifices. To others, it’s life as usual. In any case, it requires a vision, setting intentions, and having a roadmap that can evolve with you over time.

When: The Financial Crash Course for DOCTORS webinar will be given FOUR times (live) each Wednesday at 5pm (EDT) through the month of May. Seating is limited to 100 participants per webinar. We ask that you register using your work/school email – priority will be given to medical professionals.

What we’ll cover: Timely and timeless topics including:

  • COVID-19 Legislation: The impact on stimulus checks, student loans (including PSLF), and mortgages.
  • The NINE money mistakes doctors keep making
  • Fundamentals of Fiscal Fitness
  • Building a rock-solid financial foundation
  • The Juggle: Investing vs. student loan repayment
  • Physician mortgages: When they make sense (and when they don’t!)
  • Human capital: Investing in yourself

Why doctors? wHealth Advisors was founded on serving the medical community. While we can’t provide the resources they need most during this time (namely, PPE), we can offer what we know best: objective, evidenced-based financial guidance with no sales agenda or conflicts of interest.

The intended audience for this webinar includes those who are:

  • Medical/dental students
  • Interns/residents/fellows
  • Attendings or established docs that graduated medical/dental school within past 15 years

FIGS Giveaway: Following each webinar we will be randomly selecting a winner for a $25 FIGS gift card. Registering for the event is an automatic entry. Also – be sure to tag friends, classmates, and colleagues on our webinar-related Instagram posts (@whealthadvisors). More tags = more entries (limit = 10 total).

For any questions, please feel free to contact us at hello@whealthfa.com.

Follow links below to register on preferred date:

May 6, 2020 5:00 PM Eastern Time (US and Canada)

  • https://webinar.ringcentral.com/webinar/register/WN_eZ7hj5awSyaVwOqBejqDOg

May 13, 2020 5:00 PM Eastern Time (US and Canada)

  • https://webinar.ringcentral.com/webinar/register/WN_O2-njPcSQ_OeyH_H_57FJw

May 20, 2020 5:00 PM Eastern Time (US and Canada)

  • https://webinar.ringcentral.com/webinar/register/WN_tX3J4IHTSh6IyNEqVNZtRw

May 27, 2020 5:00 PM Eastern Time (US and Canada)

  • https://webinar.ringcentral.com/webinar/register/WN_FvLsh_flRRWpOf2GdV6SjQ

 

Terms & Conditions

Additional Resources:

Student Loans:

  • freestudentloanadvice.org: Great resource and created to ensure that all consumers have access to fair, free, student loan advice and dispute resolution.
  • www.nslds.ed.gov: National Student Loan Data System – best place to go when creating an inventory of your Federal loans.
  • www.annualcreditreport.com: Best place to go when creating an inventory of your private student loans.
  • Gradaway.com: Affordable student loan refinancing/consolidation company
    • $248 for balances < $100k
    • $349 for balances $100k – $250k
    • $449 for balances over $250k

Stimulus Checks:

NAPFA-Advisor-Checklist: NAPFA Checklist for interviewing Financial Advisors

Five Fundamentals of Fiscal Fitness

All 529s Are Not Created Equal

Client sitting around a table discussing fiances at wHealth Advisors office

Written by: Dennis McNamara

At wHealth Advisors, we strive to educate our clients that the location of their assets is often just as important as the funds they invest in – this rule is no exception when it comes to utilizing 529 plans. While most investment companies have faced an increased pressure to reduce their fees, most 529 plans have not. Why?

  1. Most states incentivize their residents to participate in 529 plans by offering a tax deduction for contributions.
  2. States only offer a limited menu of 529 plans (usually 1-3 different plan options).

The combination of these two factors has resulted in parents/grandparents simply settling with one of their state’s 529 plan offerings. With the steady flow of participants to state-designated 529 plans, fund managers have had little incentive to reduce their costs.

What many folks don’t realize is that a number of states (16 to be exact, NJ is one of them!) offer no substantive benefits (i.e. tax deductions) for using their state-designated 529 plans. To add insult to injury, Morningstar has just downgraded NJ’s Franklin Templeton 529 College Savings plan (1 of the 2 plans offered by NJ) from neutral to negative. REASON: The NJ Franklin Templeton plan’s most popular option, their “Growth” age-based plan, has an average fee of 1.19% while the national average expense ratio of 529 plans is .55%. Morningstar wrote about the NJ Franklin Templeton plan, saying that “subpar oversight at the state and program manager level decrease our confidence in the plan’s long-term prospects.” NOT the most promising review…

 

IMPACT:

If you invested $24,000 when your child/grandchild was three years old and left the funds untouched for 15 years, an average annual return of 7% would result in the NJ Franklin Templeton plan growing to $55,990 while the “average” 529 plan would have reached $61,291. An even lower-fee 529 plan (like one offered through Vanguard*) would have grown to $63,665 over that same period.

 

ACTION:

NJ Residents: Given NJ’s lack of 529 tax incentives and less-than-compelling 529 plans, we advise clients to explore their options. Great options to consider include:

NY Residents and beyond: Single NY tax filers can reduce their taxable income by $5,000 by making a $5,000 contribution to a NY 529. This amount increases to $10k for those who are married and file jointly.

  • BEWARE: While it’s great that NY (like many states) offers a tax deduction, be aware that participants have to choose between “Advisor-Guided Plans” and “Direct Plans” – always opt for the direct plans. Advisor-Guided Plans typically charge just over 5% for every 529 contribution. That is, each time you contribute money to the child’s 529 account, 5% of your contribution (no matter the size) goes directly to a financial salesperson’s pocket.

Don’t let fees drag down the precious funds you are setting aside for the next generation’s continuing education. As always, please feel free to contact our team to discuss this further

*Vanguard’s average 529 expense ratio is .28%

The Next Recession and What We Can Learn from the Tour de France

Three men racing on bicycles

Written by: Dennis McNamara

For the second year in a row I am a daily listener to Lance Armstrong’s podcast covering the 2019 Tour de France. As a race, the Tour’s terrain is always full of variety: flat stages, mountainous stages, and even stages with miles of cobblestones. As someone who has experienced the trials and tribulations of le Tour firsthand, Lance is rarely one to try and predict a winner. As an evidence-based investor, you also know how futile market predictions can be.

As a rider, like an investor, we can only control our actions. Riders have no control over the terrain, the weather, or the dense crowds (eh-hmm, hooligan fans) lining the roads. As an investor, we have no control over the amalgam of forces that create positive/negative market returns (i.e.  geopolitics, interest rates, currency risk etc.). Even when being pragmatic with all of the things that are in our control, we are never free from setbacks. This brings us back to the point of this article: recessions.

Looking at the chart below, we see that recessions occur roughly every four years. Given that our last recession was in 2009, it would seem that we’re due. When? Good luck guessing that one. All riders in the Tour know that there will be crashes; it’s simply a matter of when. As an investor, we need not forget that like crashes on the Tour, recessions are also a matter of when.

 

Market growth is not something that can continue indefinitely, economies need recessions to filter out the poor performers and allow opportunity for new entrants. In the Tour de France, how riders navigate the setbacks and challenging times can often be indicative to their overall performance. As an investor, those with the guts and capital to make purchases during a recession are the winners (i.e. buying depressed assets at a discount). Warren Buffett once shared the sage advice to “be fearful when others are greedy, and be greedy when others are fearful.” I’d have to ask Lance, but I feel like this holds true in both our financial markets and the Tour.

For those planning to retire or begin drawing down their assets in the near future (within the next 1-5 years), portfolio management can become a bit more nuanced. In short, it’s imperative to set aside at least a few years of living expenses in safe investments (i.e. short-term bonds with high credit quality). Why? Having these funds on the sidelines during a recession will allow you to ride out the market tumult, to not sell your equity positions out of necessity, and to be patient in waiting for the market recovery.

Aside from your portfolio allocation, the other area within your control as an investor (and arguably even more important) is your spending. If a Tour de France rider exerts all of his energy on the first mountain incline, how will he fare later in the Tour? Depleting too much energy too early in the Tour would be short-sighted and result in lackluster performance. Now, think of that same rider who exerted too much energy too early that now faces an immense challenge that is beyond his control. Good luck Chuck.

As an investor, depleting too much of your portfolio too early could have even more dire consequences than a cyclist overexerting themselves. In the event of a recession, those who rely on their portfolio assets for monthly/annual cash needs may be fine if maintaining a lifestyle within their means. However, for those living above their means, this perfect storm of a recessionary market combined with overspending will deteriorate a portfolio quickly. Trying to tighten your spending during a recession is fine, but for those in later stages of life who are already drawing down their assets for living expenses, decreased spending during a recession could be a case of too little too late.

Regardless of life stage, having a properly allocated portfolio and being conscious of your cash inflows and outflows is crucial to know in advance of a recession. Like a competitive cyclist, focus on what you can control. Whether cycling or investing, always work to be in a position of strength. If questions, contact us for a review so that when the sky is falling and market analysts cry catastrophe, you can kick back and enjoy the lighter things in life – like the Tour de France.

 

 

Trump’s Executive Order on Retirement: What You Should Know

Cheery blossom in the capital

Written by: John Munley

Out of all of President Trump’s colorful tweets recently, the one that caught our attention was a rather boring one relating to retirement, because we LOVE this stuff! While boring, if passed this could have a direct effect on how you live after 70 ½.

This summer President Trump signed an executive order for Treasury & Labor Departments to review ways to make small employer retirement plans more affordable and accessible in addition to extending and/or pushing back the Required Minimum Distribution (RMD) requirements.

In this edition, we’d like to focus on the RMD requirements and why this matters to you and making it through retirement.

 

What is a Required Minimum Distribution?

Broadly, a RMD is a Federal regulation that forces you to withdraw from your qualified retirement plans (IRA, 401(k), 403(b), 457) once you reach age 70 ½. There are situations where one may not have to take withdrawals, for instance if you are 70 ½ and still working with the employer that houses your 401(k). In the end it can be complicated, and for that we recommend consulting a financial planner, even better, a financial planner that does taxes. If you don’t have a financial planner, click here for a virtual consult.

 

Why Trump wants to change the RMD rules

Right now, if you’re 70 ½ and older but don’t need to access the money from your IRA yet the current RMD rules penalize you but if Trump’s exec order goes through, that could change. Between pensions, social security and after-tax investments, you might not need to withdraw from your IRAs to meet your expense needs. Since the government now requires you to take out pre-tax money, it means that your April tax bill increases. If my taxes increased on income I was forced to take, I wouldn’t be too happy about it either.

On the other hand, the government has given you tax-deferred growth for, most likely, decades before you have reached 70 ½. If you started with $50k in an IRA and it’s now worth $200k 20 years later, you haven’t paid a penny of tax on that $150k increase yet. So, the government politely 😉 asks for their tax money by requiring you to start withdrawing it.

Beyond the fact that this seems like an unfair policy to those who have earned and saved well, we’re living longer and therefore need our money to last longer. If you don’t need money from your qualified retirement accounts and are required to take it out, you have to pay taxes on those dollars; making it harder to plan and not outlive your assets. If the RMD requirements were reduced, then not only do you save money on the taxes you would have paid, but that tax money and the distribution itself will be able to continue to grow tax-deferred in the stock market – Yippie!

 

What those who want to keep the RMD the same are saying

Those who are against the change have three main objections:

  1. “It only helps the rich! Opponents to the change argue that those who don’t need to take money from their IRA’s in their 70’s are better off than those who need to in the           first place. So why change the rule to favor them?

 

  1. If President Trump’s aim is to help those who are in financial trouble, the rule change won’t achieve it. The average American 55-64 years old has little or no retirement savings to begin with. This proposed change will do nothing to help them. Opponents say this is just another tax break for the wealthy.

 

  1. Opponents also argue that this move will hurt our Federal Government’s already pressing budget deficit and reduce much needed tax revenue.

 

Some perspective on how you position yourself on this proposed law

5 Takeaways:

  1. If this bill goes into effect, then you will need to readjust your RMD plan going forward.
  2. If you adjust your RMD plan, your tax liability will change and you may need to update any withholding or estimated tax payments you have been commonly making.
  3. If you do not withdraw the appropriate amount from your IRAs as required, you could be facing a 50 percent penalty!
  4. If you still don’t want to withdraw the money and are charitably inclined – did you know that you can give your RMD to charity each year up to an amount of $100k per taxpayer and that amount is not taxable on your tax return. Consult a tax preparer on how to mark this appropriately on your 2018 tax return.
  5. We here at wHealth Advisors take care of all this for our clients – income tax projections so you know what you’re April tax bill will be the year before and proactive planning throughout the year prior to when your first Minimum Distribution is Required, how much to withhold, where to take it from, and how to donate and take the Qualified Charitable Distribution deduction on your tax return.

 

Regardless of what happens with Trump’s plan for RMD, your financial advisor can keep you on track to your life goals, now and in retirement.

The Path to Awesome: Top Three Financial Habits to Help You on Your Way – Part 3

A road going through nature landscape

Written by: John Munley

Build Good Credit, Early.

This is the third part of our three-part series on The Path To Awesome: Top Three Financial Habits to Help You on Your Way. I detailed in the first blog, that I was inspired to write these by a very personal response to Kid President’s exhortation that everyone find their own path to awesome. As a father and former young person myself, I see this as a chance to more widely share some of the conversations I’ve had with my own daughters about developing good financial habits to help us all get to our own, very special brand of awesome.

However, just because this wraps up our Path To Awesome discussion, the conversations about developing good financial habits won’t end, and they shouldn’t.

Throughout this conversation, I’ve (strongly) suggested that we who make the choice to take control of our life and meet our life goals need an awareness of who we are, the courage to follow our convictions and a base of knowledge that enables us to carry out our plans. These are assets we can acquire and must practice as we employ the Top 3 Financial Habits we’ll need to get to awesome: paying ourselves first; employing the magic of compounding; and using debt to our advantage — the topic of this final part of our discussion.

In fact, if you take nothing else from this article, please remember this: your credit score is a valuable asset. The good news is, you can control it. You can improve it and (the other not so good news is) you can ruin it. Pay attention to your credit report and use good debt to build up your credit rating.

 

Place Your Debts: Good Debt v.s. Bad Debt

You may be of the opinion that debt is always bad — albeit a necessary evil — but that’s not entirely true. There are some good reasons to open up a line of credit, ie: assume debt, and some smart uses for that line of credit.

Really? Debt can be a good thing?

Yes, really — but only if it’s part of your thoughtful, purposeful, goals-oriented plan.

You may have read a few articles about how high-flying financial wizards leverage debt to build empires, but you don’t have to be a Wall Street whiz kid to realize some advantages associated with ‘good debt’.

But what exactly IS good debt vs. bad debt? In a nutshell:

  • Good Debt is any debt that allows you to increase your wealth. It can be looked at as an investment, just like a bond or stock.
    • Examples
      • Mortgage – allows you to purchase your home, build net worth, receive tax benefits,
      • Home Equity Loan or Line of Credit – allows you to draw upon the built up equity in your home to use for home improvement, emergency situation, or other need,
      • Student Loans – provides you with better education, which should result in higher income potential or life achievement.

While….

  • Bad Debt is debt on consumables with no long term value.
    • Examples
      • Credit Card Debt – debt to supply short term living/spending needs – be careful!! Don’t hold revolving debt! Interest rates are also exorbitantly high.
      • Auto Loan – cars depreciate (ie: lose their value) very quickly. An auto loan is debt on a depreciating asset, as opposed to a mortgage which is debt on an APPRECIATING asset. However, occasionally automakers offer low interest rate incentive deals. To qualify for these low rates, borrowers need a high credit score (another good reason to build up that credit score).

For those of us just starting out in our careers, or even those of us who are gifting ourselves with a complete overhaul of how we manage our financial assets, this is a good, basic snapshot of the difference between good and bad debt.

 

Building Your Trustworthiness through Smart Debt

So, to buy that car, rent that apartment or buy that house — unless you’re paying cash — you want to get approved for a line of credit and get the best interest rate and most favorable payment terms, right? If lenders see you as trustworthy, you will!

 

If you can, it’s a  good idea to start establishing credit as early as the college-age years. A number of organizations and businesses use credit checks to approve applications, including landlords for your apartment, banks for your loans, even potential employers.

Conversely,

  • If you have no credit history, you are considered a risk and the lender may either not lend to you or lend to you at a higher interest rate than normal,
  • If you have bad credit, lenders will definitely not lend to you  and if by some chance they do, your interest rate will be astronomical, and
  • If you go to buy your first home (or a new home) and have low credit score, it might be hard to get a “pre-approval” from a bank. Usually, sellers want to see some kind of pre-approval to show you have the creditworthiness to even have your purchase offer considered.

So we see that we should all include building a trustworthy credit history as part of our life plan. Besides bank loans for things like cars and homes (and businesses, too), the other common type of debt people assume is:

 

Credit Card Debt

So what about credit card debt? Is it always ‘bad debt’?

The answer is the same as with other types of debt — it depends.

Is your use of a credit card part of a thoughtful, deliberate financial plan based on your life goals?

Or not?

It’s very easy to just swipe  your card and get your “stuff” without feeling the full impact of what it costs you. Too often, this leads people to live outside of their means, which almost always results in a self-defeating cycle of continuing to run up credit card debt.

There are two principal problems with credit card debt. Both of these problems come as the result of carrying a revolving balance (ie: you aren’t paying off the full amount you owe each and every month).

First, if you don’t make your payment on time, the lender charges you interest. If you carry a large credit card balance, you may be spending money you should be allocating to your savings into paying off that revolving (read: expensive and counterproductive) debt. How bad a move is this? Remember the magic of compounding? Yeah, it’s a bad move.

By carrying a revolving credit card debt, you are essentially robbing yourself of your own money to pay interest on the loan you took out to purchase items that you probably couldn’t afford according to your spending plan.

The second major problem with carrying large, revolving credit card debt balances is that you are going to pay a TON of interest on whatever you’ve purchased, driving up the cost for everything you buy on that credit card. For example, right now, credit cards are charging anywhere between 16% and 39% in interest. So that cute pair of shoes or that monogrammed newest-awesome-fiber-filled hiking jacket you bought for 50% off is going to cost you much more than you paid for it by the time you include the credit card interest payments on those items.

The lesson or good habit to learn and practice here is — pay off your credit cards monthly. And if you find that you can’t, then you are spending more than you earn.

 

All Credit Cards are NOT Created Equal

I don’t want to leave you with the impression that all credit card debt is bad. Credit cards are a great opportunity to build  good credit habits that prove your trustworthiness to lenders, thereby increasing your options to acquire good debt for important life goals. Just as with every opportunity, however, it pays to do some research and make smart choices about which credit cards are going to serve your purposes.

The fact is, these days there is a lot of competition among lenders to attract borrowers, and so the perks of credit cards are pretty high..Many credit cards offer rewards or cash back incentives to entice people to spend using their cards.  However, if you are applying for your first credit card, there are more important “perks” that you should be looking for such as no annual fee, low interest rates on balances, cash back for good grades, no late fee on first late payment, and no foreign transaction fees (Spending a semester abroad?).

Bottom line, do your research. You can shop smart for the kind and terms of debt you assume–just like the big wheels on Wall Street!

And don’t forget, every time you practice good financial habits like using good debt to build a high credit score, you are taking one more giant step along your path to awesome!

The Path to Awesome: Top Three Financial Habits to Help You on Your Way – Part 2

John Munley Financial Advisor at wHealth Advisors and family

Written by: John Munley

Last week, I shared some advice I want to gift to my young daughters about establishing good financial habits, early. My inspiration was a speech the principal at my daughter’s school gave during her moving up ceremony. I was especially moved by a quote by Kid President about The Path to Awesome.

 

This week, my focus is on some of the nitty-gritty specifics of early investing strategies because the money we earn (or receive as gifts) really can continue to grow with us — if we take even a few hours to learn more about some simple principles and investment tools. And this IS important (and I hope my daughters are listening!), because the earlier we begin using these principles and tools, the more money our investments will earn and the more freedom and options we’ll have as we travel on our path to awesome.

 

As we consider what will best serve our goals to build a solid financial future, remember that in order to accomplish these goals, we’re going to need three things: Awareness, Courage and Knowledge. We need these because, as with most decisions in life that have the potential to significantly propel us forward towards our goals, success depends on being aware of our feelings, thoughts, desires and fears about the goal; having the courage to take action and respond to the consequences of those actions, and acquiring the knowledge necessary to make the best possible decisions in the first place.

 

Depositing all your money in a traditional savings account is certainly one option for investing your money, and in some cases, it’s a great idea. But is it the best idea for building financial assets for the long-term?

 

Here’s an unambiguous answer — No. And here’s why.

 

#1: The Magic of Compound Interest

 

I am sure you have heard of the term compounding before but may not be sure exactly what it is. The easiest explanation — compounding means you are earning interest on your interest.

 

For example, let’s say you have $100 in an investment account and are earning 7% per year in interest. After your first year, you will have $107 in that account. In the second year, you will not only be earning interest on the original $100 but also on the $7 of interest you earned in the first year.

 

You’ve probably heard, repeatedly, about the benefits of starting to save at an early age — the earlier the better. Compound interest is the reason for this. Taking advantage of compounding is sound financial advice at any age, but the younger you are when you start saving, the longer your money has to grow. And the longer your time horizon, the more easily you can bounce along with the fluctuations in the equity markets.

 

I gave an example of compounding in my last blog. There, I was using it to prove my point that the earlier we begin saving, the more money we’ll have down the road, but it’s also a great example of the magic of compounding. Here’s a quick peek at how that works laid out in a neat little chart:

#2: Risk and Reward: How Courage and Knowledge Pay Off

You have worked hard for that paycheck.  You’ve set a goal for yourself to build your savings early and to give yourself the most options along your path to awesome.

 

Now, the question becomes how to invest that money so that it can do the job you need it to.

 

We just learned why compounding is the real-world magic we need. How best to wield it? Not through parking our money in a saving account, so how?

 

There are a (mind-boggling) host of investing options that come with various degrees of risk and return and, in general, the lower the risk, the lower the return will be. A savings account is certainly the least risky, but your return is also lower than with other options. The important thing to remember is that there is not just one right investment strategy and there are no get rich quick schemes.

 

In my opinion, though, the fact that you or your child is starting early (and if not early — let’s give ourselves a thumbs up for beginning today!) is the most important factor in reaching your goal. Let’s take this example: you graduate college and your new employer gives you a $10,000 sign on bonus. It would be very tempting to throw a party for you and your friends, or go out and spend that money on cool, self-congratulatory swag (but first you would remember the obvious taxes due – about $3,245 of them when you consider statutory federal and state tax withholding requirements, Medicare tax, and Social Security tax…so your $10,000 party would really only be $6,755 party).

 

But, being the wise person that you are, you remember from reading the earlier blog, So You Teenager Got Her First Job – Now What?,  that most Americans are not saving enough to maintain their standard of living in retirement. So instead of blowing that tidy sum, you save it. Depending on your goals, maybe you save all of it. I can tell you that if you are serious about financial freedom, saving the bonus into your new company’s 401k plan allows you to keep the whole $10k instead of netting only $6755 after tax as we discussed above.

 

Here’s where knowledge about personal finance is a most valuable asset. Take the time to learn why and how money can be a great tool to help you reach your biggest, most cherished goals. Community colleges often offer personal finance classes for reasonable tuition that will give you a good understanding of basic vocabulary and principles. Bottom line, the more you know, the better your decision-making.

 

For the sake of this example though, let’s keep it simple and compare your return on investment in two different scenarios: 1. Deposit your bonus in a traditional savings account (ie: Park and Ride), and 2. Invest your bonus in the stock market (Knowledge + Courage).

 

In scenario 1, if you simply dropped it into a savings account, you would only be starting off with $6,755 (remember those darn taxes) and based on the average historical rate of return for a traditional savings account (about 4.5% since 1954), after 43 years you could expect to have a total balance of $44,063. This savings rate would have resulted $37,308 of earnings over that time.

 

In scenario 2, you instead elect to save your bonus into your 401k. This gets you the full $10,000 (defer those taxes!) to invest. If we assume the long term average return of a moderate portfolio (made up of 60% in stocks and 40% in interest earning assets), saving that $10,000 bonus at the age of 22 into the a tax efficient, diversified investment portfolio would turn into $361,302 by the time you reached the age of 65. Now how many parties can you throw with that??! There’s that good old magic of compounding interest at work for you!

 

#3: Short Term Goals: When the Right Decision Means Spending NOW

Now, not all of your money should necessarily go into the equity market. After all, we need to grow and build and live and enjoy life along the way to retirement, right? Life is happening every day between here and retirement!

 

For our important short term goals such as traveling, a downpayment for a house, or purchasing a car, we want to keep our money safe and away from the volatility of the equity market and, more accessible. We want to make sure that money is readily available when you need it, so leaving a portion of your money assets in a savings account or other lower-risk investment is a great idea.

 

How much should you put into a straight savings account? I tell my daughters between 10% and 15%. As you see your income and your balances grow and you see your goals and aspirations develop, you may decide to rebalance this percentage.

 

Then, as you see your investments grow and start meeting some of those early goals — you’ll likely want to start working with a trusted financial life guide, someone who has expertise in not only how to save and invest but who also has a wealth of experience from helping others succeed…and lessons learned from other people’s mistakes.

 

Together, you can employ self-awareness, courage and knowledge to make sure you’re on the right path to awesome.

The Path to Awesome: Top Three Financial Habits to Help You on Your Way – Part 1

Wooden steps down to the beach

Written by: John Munley

My daughter recently had her moving up ceremony during which she and her class celebrated “graduating” from elementary school and starting their middle school years in the fall.  During the ceremony, the principal addressed the parents and students, quoting Robby Novak. Novak, who also goes by the name, Kid President, is a 13-year-old boy who, despite living with osteogenesis imperfecta, a rare genetic disorder that makes his bones extremely brittle, has built an online empire using his intelligence, charm, wit and boundless optimism to inspire others.

“Two roads diverged in the woods and I took the road less traveled and it hurt man. Really bad! Rocks! Thorns! And Glass! But what if there really were two paths. I want to be in the one that leads to Awesome!”

Was my daughter listening? I was. This advice is useful for people of any age, and it’s a message I hope my daughter heard, and heeds.

There have been many renditions of this theme, but they all have similar meaning:  one of the greatest gifts we have in life is the right to choose. We all have our own set of assets and liabilities, but ultimately — no matter what our circumstances — it’s up to us to choose which trail in life we want to take. And though it’s true that no two of us are exactly alike, like Robby, I believe that regardless of what everyone else does we should choose the trail that leads to our “Awesome”.

Now what does this all have to do with good financial habits?  Well, to follow your path to Awesome, I believe you need three things:

First, you need awareness about who you are, what is right for you, and where you want to go in life.

Next, you need to have the courage to follow your convictions.

Finally, you need a base of knowledge that lets you carry out your plan.

And here’s where I am going to build on Kid President’s advice with some advice of my own, hard-earned wisdom that I hope my daughters will heed along with Robby’s. Even if you’re not a teenager embarking on their first job, this is a good reminder about how to set priorities and blaze your own trail to awesome.

One of the most important things to remember about being Awesome is that it is not easy. Getting to your Awesome is an amazingly connected and complicated process because our own personal journey to awareness, courage and knowledge can’t be accomplished overnight. In my experience, we get to Awesome through hard work, determination, and sacrifice.

And though — first and foremost — the path to our Awesome is about personal fulfillment and contentment, one of the first things any of us can do to ensure success as we begin our adventure is to start practicing good financial habits, early. Because no matter what your Awesome looks and feels like, having a solid financial footing will make the rough patches easier and give us more options for celebrating our victories.

The three financial habits I wish I’d started earlier are not arcane, complicated concepts, but they do require awareness, courage and knowledge if we’re going to practice them successfully. They are: Pay yourself first, Don’t Just Park Your Money, and Avoid Building Excessive Credit Card Debt.

Pay yourself first.  What does paying yourself first mean, and why?

You provided your time, service and expertise — maybe even your physical strength. You got paid.

Shouldn’t the first person to benefit from that paycheck be you?

Of course. Your time, expertise and service is valuable. Prioritizing yourself when you get paid shows an awareness of the value you bring to your work.

So, before you go out and buy that concert ticket or video game, set aside a portion of your pay for yourself — to save. The first spending that you do each month should be a deposit to your own saving account and thinking of personal savings as the first bill to be paid each month will help you acquire wealth over time.

There is a lot of pressure to ignore your own value and prioritize other’s wants. But it takes some courage to put yourself first, or even to say no, or not now. Fashion-Store wants you to buy the latest style of jeans. Friends want you to blow half your pay on hanging out with them at the beach.

But if you do pay yourself first, your money (and it IS your money) will be able grow faster (and $$$$) as you’re able to take advantage of compound growth. And the more money you save, the more you will have to use for your goals on the way to Awesome.

A good way to develop and practice the habit of paying yourself first is to open up both a checking and savings account. Have your paycheck deposited directly into your checking account and then, on every payday the first thing you should do is transfer the money you want to save from the checking account into your savings account. This is good practice because you’re training yourself to prioritize your own needs and goals over the latest consumer trend or impulsive desire for instant gratification.

How much, though? How much should you put towards savings from each paycheck? Here’s where knowledge plays its part in your newfound, good financial habit-making.

How much you should save can either be a specific dollar amount, or a percentage of your earnings, depending on how much you’re earning, your age and your goals. At a minimum, I recommend putting 10% aside for savings. As you earn more money and see what your spending habits are like, you can adjust the amount to better meet your goals. Of course, you have to have goals to do this.

What are your goals on the road to Awesome?

One quick example of how saving early can reap HUGE rewards along the road to awesome: Start investing $2,000 a year in average yield (7%) stocks at 17, and stop contributing at 30. By the time you’re 65, you’ll have $515,231 (all earned with only $28,000 of your hard-earned money!). Alternatively, if you wait until you’re 31 to start saving, you can invest $2,000 a year until your 65 — that’s a $70,000 total investment — and you’ll only realize $295,827 by the time you’re 65.

Bottom line, no matter how old you are, #1 Habit: Pay Yourself First. Start NOW!

Enjoying this topic? Don’t miss Part 2 – “Don’t Just Park Your Money”

So Your Teenage Got Her First Job – Now What?

Woman checking out at counter

Written by: John Munley

My twin daughters got their first real jobs last summer, a common rite of passage through adolescence and good preparation for increased independence as they began their college adventure. I was a very proud parent. My kids would finally earn their own money and learn responsibility – or so I thought.

Little did I know at the time that my role and guidance as a parent was still very much needed.

When our children get that first paycheck and look aghast at the withholdings; that’s when we realize our kids know very little (or possibly, nothing) about how finances work. And maybe that shouldn’t be a surprise.

When something is provided to you automagically (like money for the movies or a new pair of yoga pants) you don’t need to know how it works. But when you’re the one holding the time card (and the debit card) it suddenly becomes super important.

If your kid is starting his or her first job this summer, you’ve got a great opportunity to talk with him or her about how we get paid and all the ways we could and should be spending those hard-earned dollars.

Here’s what to expect when your child works this summer.


Baby’s First W4 Form. You must be so proud.

After getting a job, the first thing that your teenager is most likely to bring you is a W-4 Tax Form. Employers use this form to withhold the proper amount of federal income tax from paychecks. The biggest challenge is deciding how many allowances to  claim. The more allowances you claim, the less federal income tax your employer will withhold from your paycheck.

The first thing that you want to check is if your teenager is exempt from having Federal taxes withheld  from her paycheck. The following chart published by the IRS will guide you to see if your child qualifies for exemption from withholding.

If your teenager does not qualify for exemption, then she must choose the number of personal allowances to claim. The Personal Allowances Worksheet consists of lines A through H and helps to calculate the allowances that your child should take. In most cases after filling out the worksheet, she will end up taking either zero or one allowance. With zero allowances, more federal taxes will be withheld which will lead to a larger refund at the end of the year. States may also have their own W-4’s which the employer may require.


The first paycheck. Where did all my money go?!

Your child gets a job for $10/hour and works 30 hours per week. When her first paycheck arrives, she’s shocked to learn that her total ‘take-home pay’ isn’t $300. You now get to explain the tax system and the difference between gross pay and net pay.

Use this as your basic script:

Gross is the amount earned based on salary and hours worked. Net is the actual take home pay after taxes are deducted. Everyone, regardless of age or income, has Social Security and Medicare taxes withheld from their paychecks which won’t be refunded when a tax return is filed. The Social Security tax counts towards your child’s earnings record, which is important as it’s used when determining her future benefits. If your child filed exempt on her W-4, no federal taxes are withdrawn. If she claimed zero or one, there will be federal taxes deducted from her earnings in addition to Social Security and Medicare. State taxes may also be deducted based on the state W-4 form that your child filled out.

Have fun laying all that out for her.

 

The double edged debit card.

How  we pay for goods and services is an important decision that I don’t think we  discuss as much as we should. Technology gives us multiple ways to pay for that new app or that concert ticket : debit cards, credit cards, checks, online payments, Venmo, Paypal, Apple Pay, etc.

Notice the one thing that I left out? Cash. The good old American dollar.

We live in a world where we hold less cash and increasingly use various cards and electronic payment methods. While paying electronically is convenient, there are some benefits when using cash.

First, we spend less when we use cash. Consumers are likely to spend more money using credit cards since it’s less painful than paying with cash. There is a separation in time between when the credit card is used to buy something and when the bill has to be paid, and this encourages us to be more impulsive spenders. With cash, we feel the pain of loss (our money!)  immediately.

Second, not only do credit card users spend more, but they’re spending more money to instantly gratify unhealthy choices (read: donuts and caramel lattes).

Finally, those who pay with cash enjoy a better relationship with their purchased products and are more likely to have an emotional attachment with their purchase.

I’m a realist, and I recognize that in today’s world cash is no longer king. Most transactions are carried out electronically and – eventually – we may see cash as currency disappear completely.  However, I think it’s important for teens to learn the value of cash. It is so easy moving money electronically from one place to another that it’s more like a videogame than a transaction.

It’s more painful to have to reach into your pocket or wallet and take out that $110 for the new pair of sneakers or $80 for the latest Xbox video game than it is to swipe a card or click the PayPal icon. When paying with cash, you think hard about the purchase you’re making. With credit cards and other electronic payment choices, you can buy it now and worry about the impact on your net worth later.

I encourage my twins to make half of their purchases using cash.  While the paper U.S. dollar exists, I want them to think hard about the purchases they make, and hopefully prevent them from building up debt or spending more than they have.

 

Saving for retirement (even though they’re totally never going to be that old).

One of the most important things your child can do at this early stage in their working lives is learn to save. I will tell you now that the last thing your kids want to hear is that they should begin putting money aside for retirement. The 45 to 50 years between the halcyon days of youth and when retirement will start for your child may as well be a million years away to them. However, the fact is that most Americans are not saving enough to maintain their standard of living in retirement.

Teaching our kids – now – the importance of setting money aside will pay huge dividends for them down the road. The most important reason to start saving now is the power of compounding, or the accumulation of extra money on the interest/gains received from investments. The more you invest and the earlier you start means your savings will have that much more time and potential to grow.

One of the best ways to start your child saving is through a Roth IRA. To contribute, you only need earned income from a job. Up to $5,500 can be contributed each year, and the contributions can be withdrawn tax-free and penalty-free at any age. After age 59 ½, the earnings can also be withdrawn tax-free.

Here’s a thought, tell your son or daughter that if they save $50 from every paycheck toward their future you’ll match it dollar for dollar.

 

The hard lesson: You can’t buy everything you want (but you can buy some big stuff later).

Now that your teenager is earning her own money, I’m sure she’s thinking about the numerous ways she can spend it. Now is a great time to introduce the concept of budgeting. And you can do this without a spreadsheet.

Your ultimate goal is to teach your kid how to achieve a balance between money coming in and money going out.

The first thing to do is to sit down with these spenders and clarify what you will pay for and what they are responsible for. This is especially important with college age kids. (My girls were shocked to learn I wasn’t going to pay for spring break.) Are they responsible for paying part of their tuition? Books? Social events? Meals?

You can do the same with high school kids as appropriate. Do they have to pay for any of their clothes or entertainment or meals with friends? This is your baseline for a spending plan. (Maybe we don’t say to our kids “budget” lest they think we’re cramping their new found ability to make it rain at Applebee’s.)

Help your teenager write down the income she’ll earn this year and all the known expenses she’ll be responsible for. After accounting for expenses, your child should come up with a list of goals she wants to achieve – buy a new computer, a fancy phone upgrade, maybe even a car. Now she’ll have a good understanding of how much money she needs to save to get there. And you might just get to keep some of your hard earned cash.